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Ackman Takes Ax To Herbalife, Company Says It Is 'Not An Illegal Pyramid Scheme'

With that, hedge fund manager Bill Ackman began a blistering three-hour assault on the nutritional supplement company, concluding the company is nothing more than a pyramid scheme that recruits unwitting “distributors” with the promise they can achieve the lofty incomes only reached by a miniscule subset of those involved in the business.

Shares of Herbalife, which slumped Wednesday when news of Pershing’s short position broke, dropped another 9.8% Thursday and is off more than 23% for the week.

Ackman pledged to make his presentation, along with the bevy of documents the company used to put it together, online in its entirety for investors to peruse, but the basic argument boils down to a few critical factors. (Business Insider has already published the entire slide deck.)

For one thing, Pershing believes the company inflates suggested retail price and retail sales in its public filings, in order to “conceal the fact that recruiting rewards earned by distributors are substantially greater than the sales to consumers.”

Herbalife allows upper-echelon distributors to earn rewards for not only every new recruit they enlist, but every recruit those recruits enlist and beyond, seemingly in perpetuity according to Pershing’s analysis. Other multi-level marketing (MLM) firms, like Avon Products, cut off the payments past a certain level.

The fuel that keeps Herbalife’s engine running is fresh recruits, Ackman says, and when the company runs out of new candidates in one country it simply shifts to another or delves deeper into a different segment of the population – like the Latino community.

Two hours after the closing bell, the company issued a statement asserting that Ackman’s presentation “was a malicious attack on Herbalife’s business model based largely on outdated, distorted and inaccurate information.” Herbalife “is not an illegal pyramid scheme,” the statement reads, though it does not address any of the specific questions posed by Ackman. In fairness to the company, the presentation did run for more than three hours and use more than 300 slides.

Wednesday, before Ackman’s presentation, CEO Michael Johnson told CNBC that labeling Herbalife a pyramid scheme was a “bogus” accusation, and called on the SEC to investigate Pershing Square for market manipulation.

Pershing has no position in any options, Ackman said, after Johnson raised questions about his timing relative to a looming expiration riday. The hedge fund is also not short any other MLM firms, Ackman said. It could have made quick money by assuming that companies like Nu Skin Enterprises and USANA Health Science would fall in concert with Herbalife Thursday – they were down 3.8% and 4.1% – but “we only shorted this one,” he said, to the tune of more than 20 million shares.

Ackman’s presentation in midtown Manhattan took on the feeling of a late-night television show at some points, with everything from guests – he brought out the Pershing analyst who has analyzed the stock for more than a year and the firm’s senior legal counsel to explain the case law around pyramid schemes – to hearty laughter from the audience, which came when he displayed pictures of Herbalife “nutrition clubs” that looked more like dingy speakeasies than the fast-food chains they have been compared to.

Ackman, who pledged to donate any personal profits from the Herbalife short to charity, as he did several years ago with his bet against bond insurer MBIA, thinks the winnings from the massive bet will be substantial.

“Our target price is zero,” he said, “because we think the business will fail.”

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Let me be clear that I am an obvious fan of “real” network marketing as a business model. I have come to believe that many companies are not set-up to help a large percentage of people achieve their hopes and dreams.

The fact is that not all network marketing companies are the same. There is a big shift in awareness and this morning I was sharing that an awareness of the plight of the distributor base that does not succeed based on compensation plans is becoming mainstream. It is painful, it will challenge the industry, but in the long-term it is good for “real” network marketing.

Is this my opinion? No. Here is one fresh example of elevated awareness.

Regardless of your thoughts on the specific case of Herbalife, the point is about public perception, federal regulation, and the role of the mainstream media focusing on the network marketing industry. In the future the new distributor will become better informed. If this premise is true what does it mean for network marketing companies and industry leaders?

In addition to Herbalife, another scam everyone should be aware of is the Amway Tool Scam. Google StopTheAmwayToolScam for more information, and forward this to every non-IBO you know, so they don’t get scammed.

Dear Mr Ackman, In this Christmas season, please make a review…. Do you know that hundred of thousands of families work hard and live from Herbalife? Yes Herbalife is a wealthy company but the difference with other companies is that it shares its wealth with the poorest distributors in many countries. Please go walk in Mexico streets…Come to Beirut …. Look!!!… Ask!!! Merry Christmas!

The Pershing thesis is that in reality only a tiny percentage of Herbalife distributors are drawing any gross income from their efforts (and that’s before taxes and expenses).

Ackman argues that Herbalife targets exactly the poorer groups you are referring to because they may not be as savvy about such schemes.

If you have evidence that supports the company’s defense (and remember, with millions of distributors, a handful of success stories is akin to cashing in a winning lottery ticket), I’d be happy to hear it.